The Yu’ebao app has found its way onto the cellphones of many Chinese customers

Ma Weihua, former President of China Merchants Bank, is highly impressed by his first experience of depositing thousands of yuan into a newly opened Yu’ebao account. “The emerging Internet finance product quickly won my favor, because I can see how much [interest] I earn a day just by clicking on a mobile phone application,” said Ma.

WhenAlibaba,China’s largest e-commerce group, offered the wealth management service - Yu’ebao - in June 2013, no one expected that it would soon come into the spotlight and become a catchphrase throughout the recently closed annual sessions of the National People’s Congress (NPC) and the Chinese People’s Political Consultative Conference.

When traditional banks found themselves caught napping by Yu’ebao, the rising star had stolen away millions of customers, and the momentum of the Internet finance shows no signs of coming to a halt. With an earnings ratio much higher than bank deposit rate, Yu’ebao has seized a total of 81 million users with aggregate deposits totaling nearly 500 billion yuan ($81.4 billion) inChina.

“The Internet is remolding Chinese people’s life. These days, it’s even difficult to take a cab without cellphone applications,” said Li Yanhong, CEO and founder ofChina’s search engine Baidu. “Online operation is even more suited to the financial market, for it involves no physical distribution,” said Li.

While Internet finance has become an irresistible trend, it’s more likely to be subject to risks, because online financial transactions can take place anytime and anywhere. That’s why the government needs to step in and strengthen supervision over the industry.

In the 2014 Government Work Report delivered at the opening of the annual NPC session on March 5, Chinese Premier Li Keqiang made it plain that the government will promote the healthy development of Internet finance, and improve the mechanism for coordinating financial oversight.

Breaking with tradition

All that is real is rational. Is that still the case for Internet finance? In developed economies, few Internet giants can grow into financial heavyweights, because their financial systems are quite complete with sufficient financial services supply and rapid innovation, according to Pan Gongsheng, Vice Governor of the People’s Bank of China, who suggested Internet finance is a good supplement to traditional banking.

Internet finance has reached out to the areas of the market which traditional banks have failed, ignored or dismissed. In the past, traditional banks could afford to move slowly by earning huge interest margins. However, the emergence of various Internet financial products has now broken such a balance.

“Internet finance has laid down a challenge to traditional banks, because interest rates have not yet been fully freed,” said Ma.

According to statistics, the bulk of the money collected by those Internet financial products is invested in agreement deposits with an interest rate that can be as high as 10 percent. If banks are caught in money shortages, which usually happen at the year-end when people tend to withdraw their deposits and when the central bank and China Banking Regulatory Commission set out to do checks, they would turn to these monetary funds to fill the gap. As more and more bank customers move their deposits to Internet financial vehicles like Yu’ebao, banks will see the money scarcity intensified.

The banking sector is being forced to think hard about interest rate liberalization.

Yang Kaisheng, former President of Industrial and Commercial Bank ofChina, believed that interest rate liberalization would allow banks to decide the cost of absorbing deposits according to their assets and liabilities, capital adequacy ratio and development strategies.

“If Yu’ebao still exists when interest rates for banks are liberalized, its earnings ratio will be analogous to the rate of demand deposits,” said Yang.

Moreover, Internet finance has filtered into almost all sectors, not just the banking realm.

“With high interest rates, Internet financial products have attracted a significant strand of customers into transferring deposits from their saving accounts. That will substantially increase the financing cost for enterprises,” argued Liu Liehong, President of China Electronics Corp., a sentiment echoed by Cao Dewang, Chairman of Fuyao Glass Industry Group, who worried that higher lending rates would cause the growth ofChina’s manufacturing industry to stumble.

Nonetheless, Zhang Xiaoji from the Development Research Center of the State Council believed Internet finance needs support from the manufacturing sector. “If there is no producer, how can Taobao vendors keep their businesses running? In fact, the market will strike a balance between the two.”

Pan said that people should not set Internet finance against the real economy, as the former can expand funds supply to small and micro businesses, diversify financing channels, improve transaction efficiency and reduce trade costs.

Supervision imperative

Wealth management products like Yu’ebao and Licaitong, a similar product launched by China’s Internet giant Tencent, are just one sort of Internet finance, an area which also comprises Internet payment, peer-to-peer lending, micro-loans, crowd funding, online marketing of insurance and fund products, etc.

“The government should reinforce the legislation for Internet finance, and make clear the rights and duties of trade subjects, requirements for market access, and the standards of transaction behaviors,” said Yan. “Efforts should also be made in ensuring fair trade, establishing the credit system, and protecting consumer rights.”

Pan also held that the supervision of Internet banking needs to be further upgraded and standardized. “Different approaches should be taken to tackle different Internet financial products. Supervision should be reinforced for products with high risks and be moderately reduced for those that have already become full-fledged. Meanwhile, different oversight departments should be coordinated to supervise financial products,” said Pan.

In addition, market-oriented reforms, such as relaxing price regulation in the traditional financial sector, should be pushed forward, while market access should be expanded to admit more micro-financial institutions and private capital into the financial market, said Pan.